A Curious Private Market Investor Asking About Intermediate Term (3 - 5 Year) Alpha
Hello folks - I hope you've got great holiday plans lined up. Have been a private capital markets investor for the better part of five years (PE, then venture / early-stage growth), but have some good friends who are public equities investors and have always had great respect for the tremendous intellectual horsepower that many in the asset class possess.
Having said that, I look at the current valuations of U.S. public equities, and as with a lot of other people, they look terrifyingly expensive to me. The S&P CAPE ratio is near all-time high; even the equal weighted ratio is expensive. The equity yield also looks extremely poor in comparison to bond yields now that we are no longer in the ZIRP era (my rough back of the envelope math is that a typical equity yield premium is ~2% over the last couple decades), which would imply a pretty steep drop in equity valuations or rapid declines in the Fed Funds rate that may not be warranted given continued stickiness in services inflation, the potential for tariffs, and the quiet but growing risk of federal deficit challenges.
So I'd like to ask the wise monkeys of this forum: at an index or asset class level, where do you see alpha emerging over the next 3 - 5 years, and what's the catalyst that propels that? I've seen lots of equities arguments for equal weighted rebalancing, flows returning to emerging markets (though tariffs may cause challenges there), perhaps AI driving more lift in GDP / earnings growth. I am not totally sure those are enough - but then again, I don't look at public markets all day long.
Excited to hear the perspectives of seasoned analysts here.
Based on the most helpful WSO content, here are some insights on where alpha might emerge over the next 3-5 years and potential catalysts:
Credit Markets:
Private Wealth Management (PWM):
Emerging Markets (EM):
Distressed Debt:
Sector and Single Name Plays in Equities:
Impact Investing:
AI and Technology-Driven Growth:
Frontier Markets:
These insights are based on previous WSO threads and the highest-ranked content on WSO. Each of these areas has its own set of risks and potential rewards, and the catalysts mentioned could drive significant changes in the investment landscape over the next 3-5 years.
Sources: In the near future, what will be the fastest growing Asset Classes and practices in the financial industry?, Q&A: Emerging markets investment analyst, Catalysts?, Q&A: Emerging markets investment analyst, The Best Sector, Asset Class, or investment idea for 2017 (that WSO didn't know existed)
I have some thoughts, although I'll preface this by saying I'm a senior in college so the only experience I have had has come from internships at HF & LO, so take this with a grain of salt as this could be completely wrong.
tldr:
In my humble opinion, I don't think it necessarily makes sense to look at broad measures of "cheap" vs "expensive" as indicative of whether there are opportunities to capture alpha. I see your point that (assuming someone is a LO investor), if the market is irrationally optimistic then in general there are fewer opportunities to buy companies for less than they are worth (although if someone is a L/S investor then the things you mentioned would mean more opportunities on the short side).
While the market being overly optimistic will reduce opportunities to find cheap stocks, I do think in general that there is increasing uncertainty in the world which just creates more opportunities for those who can call these changes (which by no means is easy). Maybe you think a geopolitical issue will resolve itself faster than the market does. Maybe you think software xyz is the future and the incumbent competitor is really dropping the ball lately. Or maybe you think xyz's investment in supply chain efficiencies actually will pay off as management promises, contrary to the market's belief.
Also, sometimes one company's bull case is another company's bear case. While the stocks are far from inversely correlated, think about the dynamic between a company like Ross Stores and a high end brand like Ralph Lauren. Consumers trading down is a bull case for Ross and a bear case for RL, and vice versa if consumers are trading up.
Since you're an investor I'm sure this is obvious, but from my understanding, saying "the multiple used to be this, but now it's much higher, so it must be overpriced" is not always accurate. Again, I do see your point that the high multiples mean the market is optimistic about the future, but this does not necessarily mean the market is overly optimistic - maybe things are really looking up and a higher multiple is warranted.
can't apply thought process (valuation, quality) in the private markets vs .public
Need to look at narrative - trump + risk assets + AI + crypto means catalyst for move is up. charts look great / ripping so flows have to chase and charts up to right means this continues until flows reverse.
Everyone knows this and there's nothing inherently predictive (in a reasonable timeframe) about any of the data you've given. People were making similar arguments 2 years and 2000 points lower ago. I think in general people on here, and particularly IB/PE guys, have a weak understanding of macro and what actually drives flows and positioning.
There was some dipshit analyst on here two years ago talking about going all in on a triple leveraged nasdaq position to which about 50 different people on here responded to the post with ridiculous hostility. Well this kid was RIGHT, for better or worse, and yet everyone shifts the argument to why his "rationale" for said bullish move was wrong when that's entirely missing the point.
You can't have a serious sustained drawdown, without some extreme exogenous shock, when every institutional investor already has one foot out the door because of said wall of worry.
Yes - I was also one of those people in early 2022 (and in 2019 for that matter) who was puzzled over public equities valuations. I can tell myself that I was "right" in 2022 given the index declines that year (and clearly extremely wrong to under-weight the rebound); clearly, I was wrong in 2019, but I can also tell myself now that the delta between the S&P 500 yield and Treasury yields was still very positive, which accounts for the (at the time) historically elevated S&P 500.
Clearly, though, you are correct in pointing out that my understanding of capital flows is very weak. Your last sentence implies that if institutional capital is potentially about to flow out (or has flowed out), retail capital has flowed in (or will flow in) to maintain equity values. What gives you confidence that this will continue to be the case? And at an even more basic level, what sources of data are you using to track macro-level capital flows?
It has nothing to do with retail flows nor is that something I look at in my analysis. I’m saying institutional manager have been skeptical of this rally the entire way up and positioned “long” only out of necessity hence “one foot out the door”. Skepticism provides a wall of worry to climb. It’s when everything looks rosy and they are all positioned fully risk-on that you should fear.
(1) Consensus GDP through 2026 is ~2%, are you over/under?
(2) SPX EBIT margins are 17.7% in '25 and 18.4% in '26, are you over/under?
(3 SOFR / FFF's are pricing in ~4% by Dec 25, 3.7 by Dec 26 -- are you over/under?
Obviously arguing against being long QQQ w long enough time frame, when the market is up 5/7 yrs on avg in modern times, is going to be a losing debate. I'll take that bet anyday. Hence all the passives flows. BUT... with a >3 sigma rally in the markets, entry price matters for both NT and LT returns, and the reversal risk is real so fair enough question from the OP if framed from a entry point pov. Safe to say we've priced in a fk load of future growth without leaving any real room for bad policy making, which, lets face it, with Trump is a black box, so largely un-analyzable.
Fundamentally, it would've been interesting to decompose the recent US rerating in to implied tax rate cuts, with the remainder being the "underlying" rerating of the market, or the "animal spirit" among investors which would be the real incremental risk added to the market.
Haven't seen any good reasoning how one squares what's marketed as a near-term 'pro-growth agenda' vs. LT inflationary policy making through tariffs, curtailing immigration and tapering of regulation, which, all else equal, only adds uncertainty to the slope of fed rate cuts.
But then again, as people have pointed out in some shape or form, where else do we put money to work? Betting on flows is a real shitty strategy, but there's a real lack of opportunity cost for incremental risk exposure outside the US. China isn't working (even pre-Trump tariff risk), Europe in shambles (war, no energy, lack of cap markets liquidity), LatAm still grappling with currency, debt and inflation... So what are we left with?.... Long US Inc. vs. RoW, which is a ~20 yr momentum trade.
Also worth noting that 30% of the S&P is Mag-7 and these are really incredible companies that probably deserve a premium multiple
I have a significant equity allocation but have been trimming it and going into t bills.
I find gold increasingly interesting but do not own that.
If you can pick through foreign markets there are some real cheap opportunities there, but not without issue.
FWIW I am a pessimist but not an outright bear, but am increasingly concerned about the fiscal situation in the U.S. and potential for inflation to return in a meaningful way under Trump. Paired with high starting valuations makes me feel that we are in a relatively fragile situation and I'd like to maintain optionality. My goal is basically to have enough dry powder to be in a material buying position if we do see more interesting valuations, while still maintaining a sizable (70%+, down from 90%) equity allocation since I am not a macroeconomist.
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